Emerging-Market Funds Return to Gains in July

Emerging-market stock and bond funds made a comeback in July, posting gains for the first time since March on rebounding investor confidence.

After a dismal string of losses, the funds returned an average of 1.45% in July for emerging-market equity funds and 0.34% for bond funds, according to the latest monthly data from Morningstar Inc.

In the past month, the panic that set in among investors when the Federal Reserve stated its intention to begin tapering its bond purchases subsided and asset prices made a modest recovery. Previously, market participants were worried that the withdrawal of stimulus would drive fund flows away from risk assets such as emerging market equities and bonds, and into U.S. assets, especially if the Fed began to raise rates.

However, Fed officials repeatedly noted in July that the U.S. central bank will hold off from tightening its policy until the economy improves much more. This led to a modest recovery in prices of emerging market bonds and equities.

Still, investors continued to pull money out of emerging-market assets.

In the three-month period starting May, investors have pulled out nearly $18 billion from emerging-market bond funds and $17.3 billion from equity funds, according to EPFR Global’s latest data.

Eric Fine, the $140 million fund’s portfolio manager, said he resorted to holding more cash than usual to protect his portfolio from the vagaries of a volatile market–keeping more than 10% in dollars in recent months instead of the nominal amount he typically holds.

“In this environment, cash acts as a shock absorber as we transition to a higher rates environment,” he said. Typically, his fund holds little cash but in recent months has held more than 10% in cash.

Mr. Fine also was holding onto the cash in part because he was waiting for a chance to buy dollar-denominated debt issued by emerging-market companies and countries in July. Such assets had dropped in price during the selloff.

He bought debt issued by Nigeria, Thailand, Mexico, the Philippines, Colombia and Russia, he said.

“These countries have strong fundamentals and a good fiscal stance, and don’t need to raise money anytime soon,” he said.

Nigeria in early July sold a $1 billion bond to fund its energy-distribution projects.

Bets on countries in the Middle East, for instance, that were not swayed by the global turmoil helped equity investors such as the Morgan Stanley Institutional Frontier Emerging Markets H fund (MFMHX) to report a 5.78% gain in July.

The monthly returns for the $110 million fund and its year-to-date return of 21.2% put it at the top of the 636 similar funds tracked by Morningstar.

The Middle East is home to several so-called frontier countries which are just beginning to participate in the global economy. Such countries offer attractive picks for equity funds in a range of consumer goods and electronics companies that are tied to the booming growth in these nations.